The Market For Volatility Trading; VIX Futures

This paper analyses the new market for trading volatility; VIX futures. The authors first use market data to establish the relationship between VIX futures prices and the index itself. They observe that VIX futures and VIX are highly correlated; the term structure of VIX futures price is upward sloping while the term structure of VIX futures volatility is downward sloping. To establish a theoretical relationship between VIX futures and VIX, they model the instantaneous variance using a simple square root mean-reverting process. Using daily calibrated variance parameters and VIX, the model gives good predictions of VIX futures prices. These parameter estimates could be used to price VIX options.